Business context and reporting period
HealthEquity, Inc. provides technology-enabled administration and custodial services for health savings and other healthcare accounts. This unaudited Form 10-Q covers the quarter and nine months ended October 31, 2017; comparisons are with the corresponding 2016 periods. The company reported 3.01 million HSA members, up 27% year over year, and served 87 health plans and more than 34,000 employers.
Financial performance and position
Amounts below are in millions except per-share data and percentages.
| Metric | Three months 2017 | Three months 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $56.8 | $43.4 | $169.1 | $131.6 |
| Gross profit | $33.7 | $25.9 | $103.3 | $82.1 |
| Gross margin | 59.4% | 59.7% | 61.1% | 62.4% |
| Operating income | $13.6 | $9.0 | $46.0 | $35.0 |
| Net income | $10.5 | $6.0 | $41.5 | $22.3 |
| Diluted EPS | $0.17 | $0.10 | $0.67 | $0.37 |
| Adjusted EBITDA (non-GAAP) | $21.2 | $14.5 | $67.6 | $51.0 |
Revenue grew 31% for the quarter and 29% year to date. Quarter revenue comprised service $23.0 million, custodial $22.1 million and interchange $11.7 million. For the nine months, those sources were $68.3 million, $62.7 million and $38.1 million, respectively. Custodial revenue benefited from both higher average custodial cash and improved yield.
Operating cash flow was $61.9 million for the nine months, versus $31.0 million in 2016. Investing used $29.8 million, including $15.5 million for HSA member portfolios, $2.9 million for BenefitGuard and $7.7 million for software and capitalized development. Financing provided $12.3 million, mainly from option exercises. Corporate cash and cash equivalents were $184.4 million; marketable securities were $40.7 million, for combined cash and securities of $225.1 million. Current assets were $252.8 million and current liabilities $19.5 million. Total liabilities were $21.7 million; the company had no borrowings under its $100 million revolving facility and was covenant-compliant.
At October 31, 2017, custodial assets held for members totaled $5.58 billion, including $4.59 billion in custodial cash and $987.1 million in investments. These are member assets, distinct from the company’s corporate cash and securities. The company stated its existing liquidity was expected to cover operating and capital needs for at least 12 months.
Material changes versus prior comparable periods
- Quarter and nine-month net income rose to $10.5 million and $41.5 million, respectively, from $6.0 million and $22.3 million. Adjusted EBITDA increased 46% for the quarter and 33% year to date.
- HSA members increased 27% to 3.01 million; total custodial assets rose 30% to $5.58 billion. HSA members with investments increased 69% to 98,257.
- Custodial revenue rose 48% for the quarter and 44% for the nine months. Average cash custodial yield increased to 1.85% for the quarter and 1.80% for the nine months, from 1.57% in both prior-year periods.
- Service revenue per HSA member declined about 3% for the quarter and 4% year to date, while service costs per member increased 8% and 10%, respectively, partly due to fraud-prevention measures. Interchange revenue per member declined about 4%.
- The effective tax rate fell to 20.4% for the quarter and 8.8% year to date, from 31.6% and 34.6%. The filing attributes much of the decrease to excess stock-compensation tax benefits under adopted ASU 2016-09; this included $12.6 million of excess tax benefits recognized year to date.
Outlook, management commentary, risks and unusual items
- No specific earnings or revenue guidance is provided. Management expected annual gross margin to remain relatively steady in the near term, while anticipating higher sales and marketing, technology and development, and general and administrative expenses in future periods.
- Capital expenditures were $11.0 million for the nine months, and management expected them to increase for the remainder of fiscal 2018, primarily for platform architecture and functionality improvements and office build-out.
- Management cited growth in consumer-directed health plans and HSAs, network-partner penetration, platform investment and acquisitions as business drivers. It also identified interest-rate exposure, healthcare-law and regulatory changes, competition, execution of technology upgrades, and dependence on partner distribution as important uncertainties.
- In July 2017, the Treasury authorized the company to act as both a passive and non-passive non-bank custodian. It must meet specified net-worth requirements relative to custodial funds to take on additional custodial assets.
- Acquisitions included HSA portfolio rights and BenefitGuard, a 401(k) services provider. BenefitGuard’s reported financial impact was immaterial. Acquisition-related expenses were $0.5 million for the nine months.
- The company expanded its office lease; the additional space term begins January 1, 2018 and runs through March 31, 2027, with initial annual base rent of approximately $513,000 plus taxes and operating expenses.
- Management reported effective disclosure controls, no material change in internal control over financial reporting, no material change in previously disclosed risk factors, and no litigation expected to have a material adverse effect.
- Management expects adoption of the new revenue-recognition standard to have no material impact on revenue, but expects capitalization and amortization of incremental contract-acquisition costs, including sales commissions, to significantly affect the financial statements.
Important facts for investors to verify
- Whether member growth and portfolio acquisitions translate into sustained recurring revenue, and how service fees per member and servicing costs evolve.
- Whether custodial cash growth and yields persist; custodial revenue depends on average balances, partner contract terms and interest rates.
- The sustainability of reported earnings growth given the substantial one-time or stock-compensation-related tax benefits and the unusually low year-to-date effective tax rate.
- Expected returns, amortization and integration risks from HSA portfolio purchases and the BenefitGuard acquisition, alongside planned technology investment and higher capital spending.
- The company’s ability to maintain required custodian net-worth levels, meet credit-facility covenants, and manage regulatory, data-security, competitive and healthcare-policy risks.